Amazon vs. Apple: What Should E-Book Prices Be?

Amazon has backed down from its weekend dispute with Macmillan, agreeing to charge the publisher's higher prices for Kindle editions rather than its preferred $9.99. But the long-term questions about e-book pricing remain.

Amazon still calls Macmillan's prices--generally $12.99 to $14.99 for new books--"needlessly high." Apple, meanwhile, has made deals with publishers like the one Macmillan demanded from Amazon: higher prices for books, with Apple keeping a percentage of sales.

Who, in fact, has the better strategy? To maximize revenue, what should prices for e-books look like?

The common intuition is that e-books should be cheap because they aren't physical--no printing, no shipping. Ah, say contrarians, printing and shipping make up only a tiny fraction of a book's costs. E-books aren't really cheap.

Like
publishers themselves apparently, these wise guys are using the wrong
cost figures. To calculate the cost of a copy, they're loading on fixed
"pre-production" costs like the editor's salary and the publisher's
rent. They're including the marketing budget. But these are fixed costs.
They don't change when you produce another copy. They may be important
when deciding whether to publish a book at all, but once the money has
been spent they're irrelevant to what you charge for a given copy.
Optimal pricing should be based on the marginal cost of that
incremental copy. Cover that incremental cost, and selling one more
copy is profitable. The common intuition that e-books should be cheap
reflects this basic microeconomics: Producing and delivering another
e-copy costs next to nothing.

The other side
of the equation is consumer response: How many more copies will people
buy if the price goes down? Or, in economic lingo, what is the price elasticity of demand? Book publishers talk
(and often act) as though book buyers aren't particularly price
sensitive. The Borders and Barnes & Noble coupons in my email
suggest otherwise. So does what little academic research exists on the
subject. In a paper looking at people buying physical books using a shopbot, economists Erik
Brynjolfsson, Astrid Andrea Dick, and Michael D. Smith found very large
elasticities: A 1 percent drop in price increased units sold by 7
percent to 10 percent.

Of course, people who
use shopbots are likely to be more price sensitive than average. But
there's anecdotal evidence that prices matter a lot for e-books. As The New York Timesreported recently, most of the books on the Kindle bestseller list are being given away for free. And comments on variousdiscussionthreadsamongKindleusers suggest that many are bargain hunters looking for a good, cheap read rather than a specific title.

Rather
than cut prices for everyone, Macmillan hopes to be able to price
discriminate, so that eager readers pay more than casual ones. It's a
reasonable strategy. But the publisher seems to envision a traditional
method of dividing the market: charging more for brand-new titles and lowering prices over time.
That approach works for paperbacks, which come out roughly a year after
hardback editions. But paperbacks are, of course, physically inferior
to hardbacks, while e-books are all the same. Discriminating by
publication date works only for titles that are fashion items--you
want to talk about Game Change this week, not in six months--or blockbusters with impatient fans (the latest Twilight installment). Most books fall into neither category.

If
lower book prices would generate more revenue, why, then, has Apple so
willingly adopted higher prices? Here it's worth considering the
difference between Amazon's books-plus-reader system and Apple's.

As
many commentators have noted, Amazon is not just selling e-books. It's
also selling the Kindle. To encourage sales of its device, the company
has even been willing to sell Kindle editions for less than the
wholesale price it pays for them. It's presumably maximizing profit on
the whole system, not just each individual title.

Apple,
too, is a system seller, and a device company to boot. But it doesn't
have to sell a single book for the iPad to succeed. Books are just one
app among many. If you're one of those old-fashioned people who read
books without pictures, you can download a novel between watching
videos, playing games, visiting websites, or looking at photos--all the
things the visually oriented iPad was really designed for. The iPad is
exciting not as a way to sell or read books as they currently exist but
as a tool for reinventing them as multimedia.
The book angle also helps generate good press, since journalists are
desperate for any evidence that writing will pay in the future.

Apple
doesn't need to maximize book sales. It simply needs to keep publishers
happy enough to maintain an impressive sounding inventory of titles
while waiting for entirely new forms of publishing to develop. After
all, as Steve Jobs famously put it, "people don't read anymore."

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